Google Buying Duolingo: A Match Made In Heaven (NASDAQ:DUOL)

What prompted this article?

I have been an avid user of Duolingo, Inc. (NASDAQ:DUOL) on a daily basis for over 860 days as of May, 2021, and am not planning to stop using it. Since I started using it, I have reaped significant mental benefits while improving both my Chinese and Spanish.

At the same time, I have been using Google (throughout the article we will use Google (NASDAQ:GOOG), (GOOGL) to represent Alphabet Inc.) quite actively, both as an advertiser and as a regular user, same as 60% of this planet’s population. I have recently started using Google Ads again for my own company and for a not-for-profit organization with which I am involved that has a total monthly advertising budget of over $10,000; I now have a better understanding of the power of Google Ads.

While Duolingo has been trying to use advertisement as a source of their revenue, IMHO, they have been doing a very poor job. Over my 2+ years of daily using Duolingo, I have yet to receive an ad that intrigued me enough to click on it. On the other hand, the Google ads that I receive on Google Search and/or YouTube are very pertaining to my interest and I click on them frequently.

This stark contrast between Google’s Ads abilities and Duolingo’s relatively poor ad performance prompted me to think about the possibility of Google buying Duolingo. Google would then capitalize on its advertising experience and its relatively large advertiser base to achieve a successful and profitable acquisition.

On a lighter side, mostly joking, we cannot forget that alphabets are the basics of languages and Google’s parent company needs to have a presence in the language learning business.

Summary and Paper Thesis

This article presents the justification for Google to make a play at acquiring Duolingo. A key part of the justification is the similarity of the company cultures: The employee reactions, business models, mission statement, and vision statement of both companies are quite similar, although they operate at different scales.

The reasons and benefits of Google acquisition of Duolingo are then presented together with the detailed synergies between both companies.

The dominance of Duolingo among its competitors is then presented. However, the analysis of why Duolingo has this dominance may be the topic of another article. The article then proceeds with explaining how the valuation of Duolingo would result in a price of $200+ per share.

The article concludes with what can go wrong with this potential acquisition.

Source: Created by Author from the logos of both companies

Google’s Business Model

According to their latest 10-Q for the first quarter 2022, MD&A section, Google’s revenues come from the following sources:

• Google Services
  • Google Advertising
    • Google Search & other (Google Search, Gmail, Google Maps, Google Play)
    • YouTube Ads and YouTube Properties
    • Google Network (AdMob, AdSense, Google Ad Manager)
  • Google Other
    • Google Play
    • Devices and Services (Fitbit Wearable, Google Nest, Pixes Phones, …)
    • YouTube non-advertising (YouTub Premium, and YouTube TV subscriptions)
    • Other products and services
• Google Cloud
  • Google Cloud Platform
  • Google Workplace (Gmail, Docs, Drive, Calendar, Meet, …)
  • Other enterprise services
• Other Bets
  • Health Technology
  • Internet Services

During the last quarter, only Google Services segment was the profitable segment, while the other two segments (Google Cloud and Other Bets) incurred a net loss, as per the following chart:

From the above, it is clear that while Google is trying to expand into other areas, search remains as its heart and soul.

Google’s corporate mission is “to organize the world’s information and make it universally accessible and useful.” Google’s corporate vision is “to provide access to the world’s information in one click.” Andrew Thompson provides a very good analysis of Google’s Mission Statement and Vision Statement in Panamore’s institute Business Management Publications. His analysis demonstrates the power of these statements.

Duolingo’s Business Model

Duolingo’s mission is to develop the best education in the world and make it universally available. Duolingo launched in 2012 and has since become the leading mobile learning platform globally. With over 500 million downloads, the company has organically become the world’s most popular way to learn languages and the top-grossing app in the Education category on both Google Play and the Apple App Store.

Duolingo identified its mission as: “We’re here to develop the best education in the world and make it universally available. Our global team works together to make language learning fun, free, and effective for anyone who wants to learn, wherever they are.”

You will notice that being profitable is not one of Duolingo’s objectives, and this may explain why Duolingo is not yet highly successful in monetizing their 50M monthly active users to more than 3M subscribers and not monetizing its users from an advertising perspective.

Both companies are not seeking profits as their mission: is that ok?

Not seeking profits as a key objective is not necessarily bad, and, in fact, is a commendable approach, at least according to Jim Collins and Jerry Porras’s bestselling book “Built To Last.” In it, they compared a set of “visionary” companies against the set of “comparison” companies in the 20^th century, and found that the “visionary” companies never had profit as the primary objective. Surprisingly, these “visionary” companies were multiple times more profitable than the comparison companies.

I strongly believe that the approach that both companies are taking to not put profits as their primary objective is what has made them and will continue making them successful. It reminds me of the adage: If you run after money, it will run away from you.

Is it really a “Match Made in Heaven”?

There are many synergies between Google and Duolingo; this section presents my thoughts of why this match is “made in heaven.”

Both companies rely on both advertising and subscriptions as their primary sources of revenue. Although most of Google’s revenue mostly comes from advertising, the company is moving quite aggressively toward the more stable subscription-based models. These include YouTube Premium, YouTube TV Subscriptions, Google Cloud, Google Workplace, Health Services, and Internet Services. The situation is flipped in Duolingo, where the subscription revenue for Duolingo is five times as high as that of its advertising revenue. The following charts show the sources of revenue for both companies in the last quarter ending March 31, 2022.

Both companies have similar missions, visions and strategic directions. As shown in the previous section, both companies have a mission and a vision that focuses on improving the life of their users. Both companies seem to have similar cultures; comparing the cultures of work at both Google and Duolingo show a remarkable similarity. Such a similarity would make the integration of Duolingo employees into Google a relatively easy exercise.

Duolingo has an amazing source of advertising revenue that it cannot tap into. As mentioned earlier, Duolingo’s advertising revenue represents less than 15% of its total revenue. With 50M Monthly Active Users, MAU, this represents less than $0.25 per subscriber (compare with worldwide $46.28 annual average revenue per user, ARPU, for Facebook/Meta). This shows the huge opportunity that Duolingo has not yet tapped into. Google, with its expertise in advertising, can amplify this number significantly.

Both companies rely on AI in their operations. We all know that Google is the world leader in Artificial Intelligence, and that AI is used in almost every division of the company. Google has its own AI division with a vision:

At Google AI, we’re conducting research that advances the state-of-the-art in the field, applying AI to products and to new domains, and developing tools to ensure that everyone can access AI.

Duolingo has also implemented AI in its courses to analyze mistakes and alter the course delivery to fit user requirements. As an avid Duolingo user, I can see how the application is learning from my mistakes, and how it adjusts the course delivery accordingly. Bernard Marr has a very good article about how AI is used in Duolingo published in Forbes. While AI is actively used in Duolingo, I believe that Google’s AI division can make Duolingo AI utilization even more remarkable than it currently is.

Google can use its knowledge about its users for targeted advertising. Most of the ads that I encounter on Duolingo are Google Ads through the Google network. These ads are not targeted and are linked to the cookies from the sites that I visited. On the other hand, when I watch a video on YouTube, I find the ads very targeted. The likelihood of clicking on the ads on YouTube is orders of magnitude higher than clicking on the ads in Duolingo. Having targeted advertising, which Google can provide, is what would raise the ARPU for Duolingo.

Cross marketing the advertising with existing Google advertisers can provide a very large client base to Duolingo advertising. Finding advertisers is a one of the biggest challenges for companies that depend on advertising for their revenue. This is most likely a challenge for Duolingo, thereby their using Google Ads Network, which pays a small fraction of their potential advertising revenue. On the other hand, as a division of Google, Duolingo would attract the advertisers who are already advertising in other Google venues.

Synergies between Duolingo and Google Translate. Google has a wonderful tool for translating among languages. The database behind this feature is something that can be construed as overlapping with Duolingo. I would, however, consider these two products are complementary; both databases can be merged to create a unique, more comprehensive language database.

Google has the relationships to spread the use of Duolingo to the main stream classroom. Google Classroom is one of the premier tools for managing classrooms, and this is a relationship that Duolingo does not have. Google may provide Duolingo for free, thereby enhancing the attractiveness of Google Classroom, or can potentially make Duolingo as an optional offering for Google classroom. In either case, the cross marketing between Duolingo and Google classroom would increase the profitability of both Google divisions.

Google already knows the founder of Duolingo. The founder of Duolingo has a history with Google. Luis von Ahn, Ph.D. previously sold two businesses to Google in his 20s. The first is Google Image Labeler, and the second is reCAPTCHA. This prior relationship is a very interesting one, which puts Google in the best position among its competitors to acquire Duolingo. Luis von Ahn is the kind of person that would add lots of value to Google. I personally believe that if he works for Google, he can potentially be the next CEO for the company after Sundar Pichai.

Source: Duolingo Blog; Duolingo is now a public company by Luis von Ahn

The above is just a list of the potential synergies that would prompt Google to consider acquiring Duolingo. I am fairly certain that there are other synergies that would only be known internally within Google and Duolingo.

Duolingo’s Competition

The question someone may be asking now is why would Google buy Duolingo versus another competitor. To better answer this question, let’s study how Duolingo is leading the language learning software industry. First, Duolingo is the least expensive among its competition as shown in the following table:

Company	Undiscounted Cost per User per Month
Duolingo	$6.99
HelloTalk	$6.99
Tandem	$6.99
Memrise	$8.49
Lingvisit	$9.60
Busuu	$9.99
Mondly	$9.99
Rosetta Stone	$11.99
LingoDeer	$14.99
Mango Languages	$17.99
Babbel for Business	$19.99

Source: Compiled by Author from various sources

In addition, Duolingo has the largest number of subscribers and is dominating the language learning software industry. The following chart shows that Duolingo has almost twice the subscriber number of all its top competitors combined.

Duolingo’s dominance has made it a very attractive takeover target for Google. Given the current capitalization of Duolingo ($3.3B as of the time of writing this article), I believe that Google needs to make a play ASAP.

A detailed comparison of the functionality of Duolingo against its competition is beyond the scope of this article, and may be the subject of another article.

Duolingo’s Valuation

To valuate Duolingo, I started with both 2021’s financial statements and the latest 2022-Q2 results. Adjustments were made to the specific line items in the financials to come up with the full 2022 financial projection. I then used the traditional discounted cash flow method, using the net income before taxes and before stock-based compensation as the proxy to free cash flow.

To come up with the 2022 projection, I made the following assumptions:

• I assumed that the quarter over quarter user growth rate was 6% which resulted in a compounded annual growth rate of 26% for 2022. This 26% is marginally higher than the YoY growth rate achieved in the last quarter, 23%. I believe that the growth of the number of Duolingo is a justifiable conservative number as users will continue to grow with the continued enhancements to the platform and the prevalence of Duolingo and the premier language learning tool.
• I assumed that the advertising revenue per user will be $6.86 per MAU. I believe that this number is still a relatively low one compared to what other companies are making (e.g. Facebook/Meta annual advertising revenue per user is $242.28 in North America and $46.28 worldwide). I chose $6.86 as 1/8 the annual ARPU for Facebook for the rest of the world outside North America, Europe and Asia, and I consider this as a very conservative number.
• I increased the ratio between Paid Subscribers and MAUs from 6.8% to 8%. Duolingo is now focusing, quite aggressively, on converting the non-paying users to paying ones, and this conversion has been showing a growing trend. I believe that 8% is a very conservative number given Duolingo’s low cost and the relatively low attrition that Duolingo is experiencing.
• I pegged the expenses growth rate to 25%. I believe that this growth rate is very high (very conservative). The major part of the expenditures (course development) is mostly done, and additional users do not have a significant variable cost associated with them.
• The hurdle rate was set at 12%. This number came from the CAPM model with a risk-free rate of 3%, a market rate of 9% and a stock beta of 150%.
• I assumed that the growth rate of net income will be 25% in 2023, 20% in 2024, 15% in 2025, 10% in 2026 and 5% in 2027. These conservative rates are much lower than the 41% revenue increase reported in the 2022-Q1 financials.
• The perpetual growth after 2027 was set for 3%. 3% is lower than the 3.9% average GDP growth rate in the second half of the 20th century, and I believe it is a conservative number.

Based on the above relatively conservative assumptions, the company valuation came to $8.5B. With 40M shares, we are talking about a valuation of $212. There are clearly many assumptions made here, and you might like to play with changing them and seeing what the outcome would be. I am making my valuation spreadsheet available for downloading.

Based on this analysis, Google can offer to buy Duolingo at around $212, but not much less than the all time high of $204. Google needs to act very fast, otherwise, it would forfeit the opportunity to dominate the language learning market, and a competitor may beat it to acquiring Duolingo.

What could stop this deal from going through?

While Google’s acquisition of Duolingo makes perfect sense from the perspectives of both companies, some events may result in derailing this deal. These events include:

• Google decides to acquire another less expensive competitor than Duolingo or with more compatible technology.
• Google decides to build its own language learning software based on its Google Translate platform.
• Another company makes a play to acquire Duolingo; Microsoft (MSFT) or Meta (FB) may be potential bidders here.
• Duolingo asks for a price much higher than what Google is willing to pay. This would most likely happen if the stock market experiences a very aggressive bull rally.
• The due diligence reveals certain matters that are not acceptable to Google; These matters may be related to the technology, the employee relations, the financials, the marketing strategy or any other matters.
• The regulators may put a stop to the acquisition; this s quite unlikely but everything is possible in this day and age.

The more I research this topic, the more I am convinced that the above events would not materialize and that Google would acquire Duolingo.

Conclusion

Duolingo, the world leader in language learning solutions, is an amazing company that is a perfect fit to be a Google division. The synergies between both companies cannot be greater, and both businesses would benefit tremendously from this acquisition.

Because of the synergies and the potential growth, Google would need to offer a price of over $200 per share (more than twice the current price). However, this number can go up significantly if there is a bidding war from another competitor, possibly, Microsoft or Meta.

Before you make your decision to buy or sell either company, you need to conduct your own due diligence.